Sunday, January 06, 2013

Gaining Financial Momentum in the New Year: A Canadian View by Mr. Fixit

If I were to have a list of New Year’s resolutions pertaining to financial health for 2013, it would be for amusement only, because it is the steps taken in the past and the planning over months, years and decades that really determine your overall financial health in the new year. Just for fun, here is my list:

--Debt is a four letter word, so don’t use it unless a bus runs over your toes.

--Run your household like a business that makes a profit, which is invested in the future.

--Know your habits, both bad and good, by keeping track of expenditures; this helps you plan for the future.

--It’s not what you earn, it’s what you burn! Don’t light cigars with hundred dollar bills, because smoking is bad for you. Besides, hundred dollar bills are made of plastic which emits toxins during combustion.

My wife and I have a daughter in her second year of university, another in high school and a third in grade six. We had lots of pressures and many changes in 2012, the biggest being my retiring from full time work to pursue self employment. Does this sound brave, foolish or insane? Not really; it was planned for years ago by utilizing the “run your house as a business” principle and the “invest in the future" principle. During years of high income, RSP’s were maxxed, the house paid down, and child tax credit invested in RESP’s. We couldn’t see the future any clearer than Mr. Magoo without his glasses, but knew there would be challenges. Out of this grew a cycle where in January of each year the profit from our household was invested in an RSP, which was used as a tax credit to get back the tax we paid in the previous tax year during tax season in March. It worked something like this: we invested $5000 in our RSP, which generated a $3800 tax refund, which meant a $5000 investment only cost us $1200.

Those who qualify for Canada child tax benefit and other government incentives which were designed to help families save for the future can use this money to invest. Maxxing out the RSP as previously mentioned also lowers your net income tax and qualifies you for a larger share of these programs. This money, which in its peak years would average over $800 a month, was invested in an RESP, which has allowed our daughter to pay tuition and other costs without borrowing money.

In recent years we have also taken advantage of Tax Free Savings Accounts to save money for emergencies and in lieu of life or disability insurance. Purchasing benefits can be a drain for those who are self employed, are contractors, or are working for a company which has no benefits. Again, it sounds insane, but having a year’s worth of income stockpiled to be used in an emergency without meeting some institution’s rules of eligibility while you are in dire straits is a good feeling. Most years this was accomplished on less than $40,000 a year in family income.

Now running your house as a profitable business takes some patience, and understanding that you will not drive the newest, most luxurious car. Some of your household effects will be from garage sales and thrift stores, and your decorating may be back in style as "post modernist machine age era mid century retro" several times over. Spend your money on things that retain their value or increase in value such as a home, education, antiques, and items that earn money because they are used as tools. In other words, durable goods. Non-durable goods that drop in value the minute you leave the store, such as big screen TVs, game systems, luxury items, and fancy cars, are a sinkhole and are often regretted after purchase. Most of these items can be picked up slightly used and not too far out of date at a fraction of what they cost originally.

Take a look at where you want to be this year, next year, even in twenty years; and start gaining financial momentum using some of these principles, which I can explain in more detail in future articles.

RSP = Retirement Savings Plan, also called and RRSP, Registered Retirement Savings Plan, a kind of account for holding longterm savings, in which the money isn't treated as taxable income until you eventually withdraw it (say when you retire). More info here: http://en.wikipedia.org/wiki/Registered_Retirement_Savings_Plan .

RESP = Registered Education Savings Plan, a similar account but designed to help you save for the children's college expenses. More here: http://en.wikipedia.org/wiki/RESP .

"Child tax credit" = monthly government payment based on number of children and their ages. When Mr. Fixit and I were young this was referred to as the "baby bonus." There are no restrictions on how it can be spent (or invested).

TFSAs, Tax-Free Savings Accounts, are fairly new in Canada but work in a similar to RSPS except that you can access your money more easily. You get no tax deduction for contributing, but you don't pay income tax on what you withdraw either (as you would with an RSP).http://en.wikipedia.org/wiki/TFSA